Wayfair – It's Not Just for Sales and Use Tax
The information in BDO alerts is dependent on tax policies at the time they are published. Texas finalized its amended rules, creating an economic nexus threshold for the Texas franchise tax, effective December 29, 2019. The subject matter of this alert has since been updated to reflect these changes with regard to the finalized rules.
Summary of the New Income Tax Nexus Requirements
In light of Wayfair, state legislatures and administrative agencies are re-evaluating and updating their nexus standards to adopt economic presence nexus. These new nexus standards are not just for sales and use taxes: Beginning with Hawaii, states are also implementing bright-line economic nexus rules for income and franchise taxes in this new post-Wayfair world. Massachusetts and Pennsylvania also recently issued administrative guidance imposing gross receipts-based thresholds for corporate income tax purposes. Although not adopting a similar gross receipts-based income tax nexus standard, Indiana also enacted a new nexus statute in 2019 for income tax purposes that effectively imposes economic nexus on out-of-state corporations to the fullest extent permitted by the United States Constitution. Finally, Texas has also issued an amended rule that will adopt a gross receipts-based nexus standard for franchise tax purposes.
States imposing economic nexus for income and franchise taxes is not a new phenomenon. Even before Wayfair, several other states, including Alabama, California, Colorado, Connecticut, Michigan, New York, and Tennessee, already had economic or factor-presence nexus standards for income taxes. Moreover, at least 14 other states already had judicial decisions upholding state tax jurisdiction based on economic presence nexus for income tax purposes. Wayfair likely supports these states’ statutes and court decisions, while encouraging additional states to use Wayfair and impose economic presence nexus for income taxes.
Details of the New Income Tax Nexus Requirements
Indiana Income Tax Nexus Requirements
Effective January 1, 2019, Indiana effectively adopted an economic nexus provision for its corporate income tax. Specifically, S.B. 563 revised Indiana corporate income tax law to provide that “income derived from Indiana shall be taxable to the fullest extent permitted by the Constitution of the United States and federal law, regardless of whether the taxpayer has a physical presence in Indiana.”
In comparison to other state laws and regulations discussed in this alert, Indiana did not adopt a gross receipts-based threshold or similar factor-presence nexus statute. To determine if a corporate taxpayer derives income from Indiana, effective January 1, 2019, Indiana will apply market-based sourcing rules not only for purposes of the sales factor of the Indiana apportionment formula, but also for income tax nexus.
Coupled with Indiana Wayfair standards for sales tax, which apply to annual gross revenues from Indiana sales exceeding $100,000, or 200 or more separate Indiana transactions, Indiana is now also statutorily an economic presence nexus jurisdiction for income tax purposes as well.
Hawaii Income Tax Nexus Requirements
Hawaii has enacted an economic presence nexus standard for income tax based on the Wayfair threshold. Effective for tax years beginning after December 31, 2019, a person without physical presence in Hawaii “is presumed to be systematically and regularly engaging in business” in Hawaii, and thus subject to its net income tax, if during the current or preceding calendar years the person engages in 200 or more business transactions with persons within Hawaii, or the sum of the person’s gross income sourced to Hawaii equals or exceeds $100,000. In determining if these thresholds were met, for sales other than sales of tangible personal property, such as services and income derived from intangibles, Hawaii will use the market-based sourcing approach.
Neither the new law nor existing Hawaii law define the term “business transactions,” which is used to determine nexus. Broad interpretation of this term could arguably make it applicable to any transaction, a purchase or a sale, in Hawaii. As a result, this may cause taxpayers to have nexus in Hawaii without any sales into the state. Additional guidance from Hawaii may be necessary to avoid inadvertent application of this new nexus standard to taxpayers with activities limited to purchases in Hawaii.
Massachusetts Income Tax Nexus Requirements
On October 18, 2019, the Massachusetts Department of Revenue amended its corporate excise (income) tax nexus regulation “to reflect changes in the law” including the Wayfair decision. With respect to corporations, “the Commissioner will presume that a general business corporation’s virtual and economic contacts subject the corporation to the tax jurisdiction of Massachusetts under M.G.L. c. 63, § 39, where the volume of the corporation’s Massachusetts sales for the taxable year exceeds five hundred thousand dollars” attributable to Massachusetts based on the Massachusetts sales factor (market-based) sourcing provisions. In applying the presumption, “the Commissioner will include, with respect to any corporation that has Massachusetts sales, the Massachusetts sales of a related person engaged in a unitary business with such corporation if absent this inclusion no corporation engaged in the unitary business would be subject to the excise due under M.G.L. c. 63.”
The regulations also establish a presumption of economic nexus for financial institutions if during the tax year:
- The institution regularly performs services, engages in transactions with customers that involve intangible property, receives interest from loans secured by tangible personal or real property located in Massachusetts, solicits and receives deposits from 100 or more residents of Massachusetts;
- The taxpayer has $10,000,000 or more of assets attributable to sources within Massachusetts; or
- The taxpayer has in excess of $500,000 in receipts attributable to sources within Massachusetts.
If the presumption applies, the taxpayer is required to file a return. The regulations do not provide guidance about how a taxpayer may rebut the presumption.
Pennsylvania Income Tax Nexus Requirements
On September 30, 2019, the Pennsylvania Department of Revenue issued Corporation Tax Bulletin 2019-04 regarding “Nexus for Corporate Net Income Tax Purposes.” In the bulletin, the department stated:
For Pennsylvania Corporate Net Income Tax purposes the decision in Wayfair has confirmed that out of state corporations are considered to be doing business in this Commonwealth and/or carrying on activities in this Commonwealth to the extent they are taking advantage of the economic marketplace of the Commonwealth regardless of whether they are physically present in Pennsylvania. As a result, the Department will require such taxpayers to begin filing Corporate Tax Reports so long as they meet the minimum thresholds for nexus under the Constitution of the United States.
Using the long-arm provisions of the “doing business” and “carrying on activities” clauses of Pennsylvania’s imposition statute under 72 P.S. Sec. 7401, the department will deem there to be a rebuttable presumption that corporations without physical presence in the state, but that have $500,000 or more of direct or indirect gross receipts sourced to Pennsylvania, have a Corporate Net Income Tax filing requirement. To determine whether the gross receipts are sourced to Pennsylvania, the state’s sales factor sourcing rules will apply, including market-based sourcing for sales of services and cost-of-performance sourcing for licenses or sales of intangibles.
The department will be enforcing these new standards for tax periods starting on or after January 1, 2020.
The new economic nexus standard applies “regardless of whether or not the entity is subject to federal income tax.” Thus, foreign entities that may be protected under treaties from federal income tax could still be subject to Pennsylvania corporate net income tax, as with the exception of the discrimination article, U.S. tax treaties generally do not apply to state and local taxes.
Taxpayers claiming P.L. 86-272 protection should continue to file the Pennsylvania return, Form RCT-101, to claim the exemption.
Close reading of the bulletin reveals several ambiguities. First, the bulletin currently only applies to corporations; it is uncertain if the department will expand its applications to pass-through entities. Second, neither the bulletin nor existing Pennsylvania law defines the term “indirect gross sales.” Thus, it is uncertain how taxpayers should be measuring and sourcing indirect gross sales. Third, the bulletin’s language does not expressly establish a bright line nexus, but merely creates a rebuttable presumption of nexus. The bulletin does not include any information about the standard of proof required to rebut this presumption.
There are some concerns about the bulletin’s validity. It is uncertain if the nexus policy would survive a challenge under the Uniformity Clause of Pennsylvania’s Constitution, which requires “[a]ll taxes shall be uniform, upon the same class of subjects, within the territorial limits of the authority levying the tax.” Additionally, the department’s attempt to legislate through a bulletin, rather than through regulatory process, may violate the state’s Administrative Procedure Act.
Texas Income Tax Nexus Requirements
Effective December 29, 2019, the Texas Comptroller of Public Accounts adopted an amended rule to implement economic nexus for Texas franchise tax purposes. Under the new rules, an out-of-state entity will be presumed to be “doing business” (i.e., have economic nexus), if the following requirement is met under 34 TAC 3.586:
- For each federal income tax accounting period ending in 2019 or later, a foreign taxable entity has nexus in Texas and is subject to Texas franchise tax, even if it has no physical presence in Texas, if during that federal income tax accounting period, it had gross receipts from business done in Texas of $500,000 or more, as determined under [Section] 3.591 of this title (relating to Margin: Apportionment).
According to the new rule, this presumption codifies existing practice. The new rule also indicates that an out-of-state entity with a use tax permit is subject to the Texas franchise tax.
The new provisions apply to 2019 franchise tax reports due on or after January 1, 2020. For the purposes of the threshold, nexus is determined on an individual taxable entity level. Note that for tax years 2020 and 2021, Texas Margins Tax provides for a “no tax due” threshold of $1.18 million of gross receipts.
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